Public project, private risk

Virginia looks to partnerships to tackle major jobs

If all goes as planned, 2013 will be a watershed year for commuters on Northern Virginia’s congested Capital Beltway. Under Virginia’s statute authorizing private companies to build state facilities, the Interstate 495 Beltway is undergoing massive change. Four high-occupancy toll (HOT) lanes — two new lanes in each direction — are being added along a 14-mile stretch from the Springfield Interchange to just north of the Dulles Toll Road.

The high-tech system will include highway-embedded sensors to monitor road conditions. Forty-five miles of communication cables and wireless networks will connect the sensors to flashing electronic signs, relaying information on traffic volume and accidents.

The HOT lanes will use variable tolls — “congestion pricing” in the parlance of road designers — to regulate traffic flow. Tolls typically will be higher during rush hour and lower during nonpeak periods. That means commuters face a choice: Pay the toll to drive in a HOT lane or stick with nontoll lanes and risk gridlock. Drivers won’t even need to slow down. Instead of tossing coins in a bucket, electronic gantries overhead will scan transponders inside their vehicles and debit motorists’ accounts as they enter HOT lanes at normal highway speeds.

Virginia has been regarded as a pioneer since state lawmakers passed the Public-Private Transportation Act (PPTA) of 1995. Since that time, about a dozen states have modeled similar statutes on Virginia’s law, with Arizona and Georgia among the latest converts. The law is far from perfect: Already revised twice by state lawmakers, PPTA once again is getting a fresh set of tweaks, this time at the hands of Gov. Bob McDonnell.

Amid the worst budget crisis in years — the state had to plug a $4.2 billion shortfall — McDonnell has unveiled steps to streamline Virginia’s procurement process for public-private partnerships. The goal: finally complete long-delayed repairs to bridges, roads and other decaying assets, in spite of the state’s painful money crunch. Hastening vehicles on the heavily traveled Beltway is a high-profile signature project, and some would say, a litmus test of the public/private trend.
“The Capital Beltway project is the first public-private HOT initiative in the country,” boasts Sean T. Connaughton, a former chairman of the Prince William County Board of Supervisors, whom McDonnell tapped as Virginia’s secretary of transportation.

Well, almost. State Route 91 in Southern California probably has better claim to the distinction, having launched a series of privately built toll lanes in 1995. But Connaughton’s enthusiasm is understandable: the Beltway expansion offers a glimpse into the compelling potential of public-private partnerships.

About 50 aging bridges and supporting infrastructure also will be replaced as part of the $1.9 billion “fixed price” project spearheaded by Australian road-building company Transurban and its construction partner, Fluor Corp. The private companies are assuming heavy financial risk upfront. Virginia is contributing a $409 million grant from its Commonwealth Transportation Fund; the $1.5 billion balance comes from private equity and proceeds of bonds sold by the Transurban-Fluor partnership. It also will pay to operate and maintain the toll road under a 75-year contract with the state.

“Since we’re putting $1.5 billion of our own money into this project, we are keenly interested in making sure it gets completed on time and on budget,” says Michael Kulper, Transurban’s president. “We negotiated a fixed-price, date-certain commitment with our subcontractors to deliver this facility over a five-year construction period,” due by 2013.
The current Beltway project is two years into construction and moving along rapidly. Approximately $40 million of work was completed in May alone, state officials say.

“The big thing last year was to be able to work on the bridges and overpasses,” which is as vital to Virginia as the toll lanes, says Mal Kerley, chief engineer with the Virginia Department of Transportation.

The installation of toll lanes on I-495 is not a new idea. A similar proposal in 2002 by Fluor Corp. got nixed after public outcry over its scope and cost. It called for the taking of 300 private homes and carried a $3 billion price tag. The McDonnell administration vows this version will be different, particularly since the toll road is being designed, financed, built and operated entirely by the private companies.

On paper, Transurban’s idea should not cost Virginia taxpayers. The $1.9 billion cost would increase only if Virginia requests work outside the original scope of the contract. Also, Transurban and Fluor are on the hook for all debt financing. Under the terms of the agreement, Transurban will own 90 percent of the toll facility and Fluor will get a 10 percent stake. The companies plan to pay down the debt through tolls collected on the Beltway.

Since the system is dynamic, it’s hard to be overly specific about toll prices. However, when traffic is light, tolls could be as low as 10 cents a mile. When congestion increases, toll prices will go up and could reach around $1 dollar per mile to regulate the number of drivers entering the HOT Lanes — even during rush hours, says Transurban spokeswoman Pierce Resler. The lanes would be free to motorcycles and vehicles carrying three or more people.

When Transurban closed its financing in 2007, the company estimated an internal rate of return of 13 percent on the project’s equity, Kulper says. Additionally, Kulper says the Beltway deal is the first in the U.S. to contain a revenue-sharing agreement — meaning Virginia could get up to 30 percent of earned gross revenue to use for financing local transportation improvements.

Another important distinction: Transurban is spending money it already has secured. That’s a huge departure from traditional “design/build” road projects in which contractors tap revolving credit or investors to keep projects afloat — an approach that can lead to cost overruns.

Being accountable to shareholders and investors provides tremendous incentive to meet established timelines. Should subcontractors fail to deliver on time, Kulper says Transurban could seek financial penalties approaching $250 million. Fluor also is providing financial guarantees from its balance sheet, using its AAA credit rating as collateral, Kulper says.
The $1.5 billion in direct construction spending on the HOT lanes will multiply to $3.5 billion worth of economic impact for Virginia through 2013, says Stephen S. Fuller, director of the Center for Regional Analysis at George Mason University in Fairfax. The Washington metropolitan area figures to gain about 12,000 jobs from the HOT lanes, including about 5,000 in Fairfax County alone. All told, Fuller says the project will support about 30,000 construction-related jobs in the local and national economies during the construction period.

“The biggest immediate effect is that Virginia gets a highway it didn’t have to pay for and couldn’t afford, but that it would have been under pressure to build eventually,” Fuller says.

Indeed, after years of frustrating delays, Northern Virginia commuters are pleased to see forward progress. That section of the Beltway ranks as the worst traffic chokepoint in Virginia and 20th-worst in the U.S., according to a 2009 report by the American Transportation Research Institute in nearby Arlington.

“The HOT lanes are crucial to future economic development in Northern Virginia and Virginia as a whole. It is great news for the region and particularly Tysons Corner, our major employment center,” says Keith Turner, the chairman and president of the nonprofit Tysons Transportation Association, referring to three new interchanges into and out of the busy commercial corridor.

Virginia’s government officials have learned hard lessons about managing business contracts with private companies. In 2005, the Virginia Information Technologies Agency awarded a $2.3 billion contract to Northrop Grumman Information Technology to refurbish the state’s antiquated computer networks. Missed deadlines, a billing dispute and fighting between the company and state agencies dogged the project almost from the start, though officials from both sides say those problems were resolved during recent renegotiations (see story on page 26). Skeptics, nonetheless, pounce on the VITA-Northrop Grumman flap as evidence of the drawbacks of shifting public services to private providers.

“I’m in favor of it if it leads to more effective, responsive and cost-efficient services. But my concern is that the private sector only sees the opportunity to make big bucks,” without an equal return to taxpayers, says Blue Wooldridge, a professor of government at Virginia Commonwealth University in Richmond.

Moreover, road projects tend to be complex and unpredictable, complicating matters even further. Such fears are borne out by a 2008 report on public-private highway partnerships by the federal General Accounting Office. Although acknowledging that states and localities reap numerous benefits from public-private highway arrangements — especially the transfer of financial risk — the report concludes “it is likely that tolls will increase on a privately operated highway to a greater extent than they would on a publicly run toll road.”

At least one Virginia locality is openly hostile to public-private partnerships. The Arlington County Board of Supervisors is suing Virginia, the U.S. Department of Transportation and the Federal Highway Administration to block HOT lanes proposed for a section of Interstate 95/395. County officials allege seven violations of federal statutes, including the Civil Rights Act of 1964 and numerous environmental laws. The U.S. District Court for District of Columbia in April ruled that the county’s lawsuit had enough merit to move forward.

Virginia is not alone in turning to the private sector in fiscally challenging times. It is a scenario playing out in states and localities across the country, says Richard Norment, the executive director of the Arlington-based National Council for Public-Private Partnerships.

“Budget shortfalls, decaying infrastructure, huge population growth in urban areas and projects that have been put on hold,” Norment cites as reasons for the national surge.

Virginia’s original statute has been revised to make the process more transparent. Christopher Lloyd, a Richmond lawyer who helped craft the legislative language used for Virginia’s original PPTA while working under then-Gov. George Allen, says localities must conduct public hearings for each public-private proposal to gather input from residents. Copies of proposals and procurement records must be publicly available. Plus, public-private contracts are required to be posted at least 30 days before being finalized.

Philosophical debates aside, few would dispute that Virginia’s transportation assets are decaying. That’s why one of McDonnell’s first moves after taking office last year was to commission an audit of Virginia’s PPTA. Carried out by accounting firm KPMG, it resulted in a series of recommendations to make contract negotiations more transparent. Chief among them: creation of a new PPTA program office that combines previously separate functions of the Virginia Department of Transportation.

“Our goal is to stop the long-term delays that have plagued other projects,” Connaughton says. “We’re trying to bring [private] business practices to state government — it’s that simple.”

Yet nothing about public-private partnerships appears simple. Although not as far along as the Beltway project, a public-private partnership to improve the Midtown Tunnel in Hampton Roads is nearing a final agreement, those associated with the project say. The multifaceted program calls for construction of a new two-lane tunnel running parallel to the existing Midtown Tunnel, upgrades to the Downtown Tunnel between Portsmouth and Norfolk and safety enhancements. Also planned is an extension of Martin Luther King Boulevard to Interstate 264, including a new highway interchange.

It is long overdue, but obstacles remain before the first shovel of dirt gets turned. Still unresolved are the costs of tolls proposed by the private developers to recover the estimated $1.5 billion construction cost. Set to do the work is Elizabeth River Crossings, or ERC — a joint venture between Skanska Infrastructure Development and the Macquarie Group, an investment firm based in Sydney, Australia. Macquarie spokeswoman Paula Chirhart, speaking on behalf of ERC, says the company plans to borrow $1.2 billion and raise $525 million in private equity to finance the deal.

The toll price remains a sticking point. ERC pegged its construction estimate on a toll ranging between $2 and $3 per car for both tunnels. State transportation officials want a toll in the neighborhood of $1.50 — one of several items Connaughton says must be ironed out during negotiations this summer. He predicts construction crews will break ground sometime in 2011. It’s also possible the Virginia Department of Transportation could kick in money to cover the difference, although that issue is a long way from being resolved, too.

Nor are highways the only target of public-private partnerships. Norfolk Southern Corp., one of the largest rail-freight carriers in the U.S., is using the strategy to finalize its long-planned Heartland Corridor. Estimated to cost $320 million, the new rail line would shave 250 miles off of an existing route, thus speeding delivery of goods from the Port of Virginia to Midwest markets, says Jeff Heller, a Norfolk Southern vice president.

Work on the Heartland Corridor includes raising the vertical clearance on nearly 30 tunnels along the route, including four tunnels in Virginia. The new 21-foot-high clearances will enable Norfolk Southern trains to carry freight in double-stacked containers. The expanded-capacity trains are set to begin using the route in November — much sooner than if Norfolk Southern did not partner with the public sector, Heller says.

Norfolk Southern is investing an estimated $127 million toward construction. Meanwhile, the Federal Highway Administration is contributing $125.4 million while Ohio, West Virginia and Virginia each plunk down varying sums of capital. Included in Virginia’s share of $37.3 million is $12.6 million for a new intermodal facility in Elliston, near Roanoke.

In fact, the Elliston facility is one of three intermodal terminals planned along the route. It could serve as a hub for trains carting freight from marine terminals in Hampton Roads. The cost and location of the facility still are being determined, but it promises to boost Southwest Virginia’s economy, according to one report. A January 2008 study by the Virginia Department of Rail and Public Transportation predicts the terminal will generate nearly 3,000 jobs and up to $550 million in economic activity within its first 15 years of operation.

That’s assuming the controversial facility gets built: the Montgomery County Board of Supervisors has filed a lawsuit asking the Virginia Supreme Court to forbid the project. The board alleges that it violates the state’s constitutional provision against using tax dollars to fund private industry.

Nor is Heartland the only public-private deal involving Norfolk Southern. The Norfolk-based rail giant is mapping out a 2,500-mile route known as the Crescent Corridor that crosses 13 states. That $2.5 billion proposal envisions a connected rail line meandering from Louisiana to New Jersey. In Virginia alone, the Crescent Corridor could produce 300 jobs during the next decade and divert nearly 860,000 trucks from state roads each year, according to an analysis by Cambridge

Systematics Inc., a Massachusetts consulting firm. Virginia thus far has supplied $40 million to help construct a five-mile stretch of double mainline track in Front Royal that would speed train traffic across one of the proposed corridor’s busiest segments.

In an effort to reproduce the effects of the PPTA, state legislators passed the Public-Private Education Facilities and Infrastructure Act of 2002. Also referred to as the PPEA, its helps state localities solicit private-sector companies to build schools, prisons, health facilities, wastewater-treatment plants and other capital-intensive assets. The PPEA has led to nearly 90 public-private deals since its inception, says Lloyd, the lawyer and former Allen administration official.

“It is an ideal tool for complex projects with lots of moving parts — especially ones that only get built every 40 or 50 years,” Lloyd says.

Using that standard, the Beltway HOT lanes and Midtown Tunnel easily qualify as blue-ribbon projects. Public-private partnerships are not a cure-all. Yet as needs mount and revenues shrink, Virginia seems destined to rely on them more than ever.